Dollar Debasement in Commodities, Charted

Amazing to think that it’s taken some analysts nearly two years (if not more) to discover that commodity prices might be a little more influenced by fluctuations in the dollar than real hard fundamentals.

Citi analysts made the point on Tuesday, noting that the ‘real price’ of commodities is becoming much less of a call on the value of the commodity and increasingly about the value of the dollar.

But it’s okay, since they’ve applied some high-grade elementary mathematics to make into, like, a proper theory.

As Heath Jansen’s global mining team note:

While the numerator in the pricing equitation is well known (i.e. a lump of copper), the denominator is becoming the uncertain variable (i.e. value of the US$). While historically the US$ has been viewed as the global currency it appears as if the US$ is losing its shine.

We don’t intend to be mean — but surely analysts should have been thinking about these sorts of issues for a long time now?

Although, of course, better late than never. And, we guess, they do at least back-test the theory with some logical analysis to prove their point.

As they explain, to track just how bastardised the price of commodities may have become due to dollar devaluation, they’ve looked at commodity pricing in terms of gold:

Various pinch point charts — We have plotted the major commodities of copper and aluminium against historical stocks-to-consumption ratios in various currencies of US$, euros and AUD, eliminating exchange rates altogether, and plotting commodities in equivalent gold ounces.

The market appears rational — While on a pure stocks-to-consumption ratio, commodities have moved well ahead of historical stocks-to-consumption ratio, suggesting a structural shift in commodity pricing. On a relative basis the market appears to be more rational.

When pricing commodities in equivalent gold ounces, then commodities have moved within historical trading bands, suggesting the pricing of commodities is coming down to relative value rather than an absolute value of an exchange rate. The conclusion is by increasing the money supply, commodities go up – but some commodities are more equal than others.

In other words, money supply expansion lifts commodity prices in the first instance, with some commodities — presumably the better stores of value — going up more than others.

The following copper charts make the point, they say.

Although first it’s best to consider the overall copper price trend in the period from 2003-onwards (chart courtesy of Boomberg):

With that in mind, Citi plots the quarterly ‘real’ copper price points in dollar terms versus the stocks-to-consumption time period, which produces the following pattern:

As Citi notes, there appears to have been a clear structural shift in the period — with today’s price point (in black) clearly hovering at the high-end of the historic price range, but also at the low end of the stocks to consumption ratio.

Citi then performs the same exercise, but on a monthly basis, in both dollar and euro terms — with the 2009 price points highlighted in pink:

As can be seen, both cases reveal a similar structural shift.

But now when Citi does the same thing in terms of gold — lo and behold, a very different picture emerges:

It seems, the current price is not only well within, but actually falls below the recent historic range — with stocks-to-consumption quite comfortably sitting around the middle range.